Getting from Here to There
A common theme in much of the discussion so far is that the current crisis originated with a financial system that was completely out of control--too large, too risky, with massive liquidity mismatches between assets and liabilities. In another setting I described it as a sort of financial Frankenstein.
There are different explanations of how we got here. Some see it as simple policy mistake of taking deregulation too far. Others attribute it to the malign influence of free market ideology misapplied to financial markets which are unusually prone to market failures. Others point to the political power of Wall Street and the financial elites. I am persuaded that all played a part. Most discussants seem to agree that however we got here the eventual goal should be a financial system that is tightly regulated, boring and safe.
To get from here to there is the challenge. Even a boring and safe financial system needs capital.
I believe that as a consequence of past bad lending decisions large parts of the financial system are in effect insolvent. Even if the plan to get some of the loans that are hard to value off bank balance sheets works, banks that are close to the edge will find it impossible to raise enough capital from private investors. Thus there is no way we will have a viable financial system without massive injections of public money.
It is quite clear from the way that the administration is dancing around the subject that it does not believe that it currently has the political capital to ask Congress and the American tax payer for another several hundred billion dollars to put into the banking system. The American public is furious at the excesses of Wall Street and it is going to take political leadership of the highest order to persuade voters to along with more money for banks.
There are many echoes of the Great Depression in all this. By 1933, the popular press had taken to calling bankers "banksters." And yet under Roosevelt, the RFC injected over $1 billion into banks in the form of preferred stock. (equivalent today to $400 billion adjusted for the size of the financial system) . And while there were familiar complaints about banks sitting on the capital instead of lending it out, there is no doubt that injections of public money into the banking system were a necessary condition for the economic recovery after 1933.
Unfortunately as we saw with AIG, bailing out one financial institution involves transferring money to lots of them. And it is hard to bail out banks without at the same time bailing out bankers.
I will focus on the international issues in my next post.
Too things are absolutely necessary for honest governance; transparency and punishment. There was none under Bush and there is damn little under Obama.
Further, what's necessary is far from sufficient. So we are a long way from anywhere I want to be. A long, long way.
April 15, 2009 4:52 PM | Reply | Permalink
I agree with you here. We probably need the converse of the scenario in 1984; that is, instead of all citizens being spied upon, all government activity, domestic and foreign, should be on the screen. That way, there's no he-said, she-said; treaties would be apparent, the breakers obvious; laws and their attachments, oversight, quid-pro-quos and other deals--we now have the technology to shine a light on the darker aspects of the Machiavellian machinations of politics.
April 16, 2009 1:07 PM | Reply | Permalink
I think we need people in Treasury who don't believe the wealthy traders on Wall Street are the Lords of the Universe, as Geithner seems to believe. As long as the belief persists, the government will continue to try to put Humpty Dumpty back together again, unchanged, except for a few barely visible glue lines.
April 15, 2009 6:56 PM | Reply | Permalink
Seymour Melman wrote a book called "Profits without Production" that was published in 1983. Because of the ratio of "services" to "manufacturing" activity in our country, it appears we are fast approaching an era of "profits without production." Many manufacturing corporations have transplanted their operations overseas, lured by "lower costs of production" due to the absence of organized labor unions, environmental laws and legislated minimum wages. These manufacturers would rather see Americans reduce their standards of living than elevating that of the rest of the world. Thus, stocks, bonds, and securities and other financial instruments that were based on the substance of real productive transactions which formerly attracted Wall Street financiers, investors, insurance companies, stockbrokers and the Stock Market itself, etc..., are no longer available. Still these institutions must continue to operate, as they seek to increase their profits from the same "buy, sell and trade activities." "Services" alone were not sufficient to guaranty the kind of profit rates that, for example, coal, oil, railroads, steel, trucking, automobiles and banking etc... used to generate. Thus, Wall Street "operators" began to "get very creative" in contriving "financial instruments" as profit-making mechanisms, to substitute for the missing industrial base transactions that "flew overseas," for those who disappeared through consolidations, and for those who "plain went out of business."
For example, the so-called "housing bubble" was engineered by such operations. Financiers began to "bunddle mortgages" to have them bought, sold and traded to inflate home prices at the same time, as if they were stocks and bonds backed by real production transactions or real production-based revenues. It's like these "indexes" or these "futures," that are manipulated, yet are not based on the substance of economic productivity. Since these transactions had no original capital or financing to back them up in the first place, the whole house of cards collapsed when workers lost their jobs and could not make mortgage payments. In short, financia instrument issuance must be regulated in kind and scope.
It seems that all efforts to control damages will be fruitless in preventing a recurrence of market failure, unless Congress regulates the types of financial instruments that can be "invented" for trading.
April 15, 2009 11:05 PM | Reply | Permalink
"Profits without Production" sounds like what I call Churning.
Sending mfg. overseas (out of the country) sets one up to send future wealth overseas if you then import from that mfg. America can afford to send some wealth overseas. Sending wealth overseas helps raise standards of living overseas, a little bit (trickle down, wages, ...).
April 16, 2009 3:58 PM | Reply | Permalink
Correction: "In short, financial instrument issuance...." Thanks.
April 15, 2009 11:09 PM | Reply | Permalink
Seems to me that whether you're selling stocks or bonds or insurance or sub-prime mortagages - or cars for that matter - a salesman makes money when he/she sells. (And in finance selling gets fancier with hedge funds and credit default swaps and short sales...)
Further seems to me that like what happened in the car sales business years ago, which led to stuff like the lemon law, salesmen must be forced to stand behind what they're selling and to eat it if they've misrepresented their products.
April 16, 2009 11:40 AM | Reply | Permalink